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Spain Politics October 2018

Spain: Expansionary 2019 budget faces uphill battle for approval

On 15 October, the center-left Socialist (Partido Socialista Obrero Español, PSOE) minority government, led by Prime Minister Pedro Sánchez, unveiled its 2019 draft budget. Notably, it relaxes the 2019 fiscal deficit target from 1.3% of GDP set by the previous conservative People’s Party (Partido Popular, PP) government to 1.8% of GDP, amounting to nearly EUR 6 billion in additional spending. The expansionary budget rests on a reasonable 2.3% GDP growth forecast for next year, which the government revised down due to signs of weakening tailwinds to domestic demand ahead. The proposed budget, designed in partnership with the anti-austerity Podemos party, would introduce new and higher taxes, primarily on the wealthy and corporations, and increase social spending. While potentially providing a boost to growth if approved, the budget also aims to tackle the country’s income inequality, among the highest in the EU, by enhancing the redistributive function of the tax system. However, given the PSOE’s minority position in Congress and likelihood of a Senate block, the chances of approval are slim. Hence, it is likely that Sánchez would adopt the previous government’s tighter budget and thus avoid a budgetary deadlock that could lead to a snap election. Such scenario indicates that the status quo to economic policy and a contentious and uncertain political environment will remain until elections are held in 2020.

The political challenges impeding the passing of the budget are two-fold. First, Sánchez requires backing from the very same parties that helped him oust his predecessor Mariano Rajoy in the no-confidence vote held against him in June. PSOE and Podemos together control 151 of the 350 seats in Congress, thus requiring support from smaller regional parties to reach a majority. Although the nationalist Basque party is likely to support the budget plan, Catalan pro-independence parties have demanded the release of jailed secessionist leaders and a referendum on self-determination in return, which the government has been unwilling to grant. Thus, it remains uncertain whether their backing will be secured. Second, assuming that Sánchez is able to garner enough support in Congress, the budget also has to pass in the Senate. However, the PP has absolute majority there and thus will likely block approval on the grounds that it does not meet the previous fiscal track presented by the Rajoy government. Hence, unless Sánchez overcomes these political obstacles, it seems that the 2018 budget will be rolled over to next year, which also illustrates the challenges his government will face to pass legislation in the months to come.

In the unlikely scenario that it does pass in both legislative houses, the budget contemplates a 3.1% rise in spending to EUR 516 billion which will be partially compensated by a 5.7% increase in revenues to EUR 493 billion. On the revenue side, highlights include higher taxes on corporations and high-income households, and a new tax on financial transactions and online advertising. Meanwhile, spending would be increased in pensions, education and social housing. The budget would also lift the minimum wage from EUR 736 to EUR 900 per month. In contrast to the previous Rajoy administration, where the narrowing of the fiscal deficit was achieved through the impact of economic growth, authorities argue they will deliver a structural adjustment through the permanent higher revenues generated by the proposed tax reforms. In addition, authorities project a primary surplus of 0.5% of GDP, the first since 2007. This would enable a faster reduction of the public debt compared to what was achieved under the previous government, from 98.1% of GDP in 2017, to 97.0% this year and to 95.5% by the end of 2019.

Meanwhile, although Spanish 10-year bond yields climbed through the month in anticipation of the budget’s release, investor reaction was less severe than Italy’s case, which suggested more market confidence in the proposal. After its unveiling, the Spanish-German bond spread also rose to levels last seen during the no-confidence motion events of late-May, likely reflecting heightened uncertainty associated to developments in Italy and over the European Commission’s response to the submitted budget plan. Although the Commission sent a letter to Spanish authorities on 19 October requesting further information on the budget, it is expected that the Commission will ultimately give the green light as previous negotiations between both parties yielded an agreement on the proposed looser fiscal track.

All in all, given political roadblocks, namely not enough votes to back the plan in Congress and opposition by the PP-controlled Senate, the likelihood that the budget is approved is low. Thus, the most likely scenario is that Sánchez implements the inherited budget from his predecessor while waiting out his term until the general elections of 2020. Moreover, the government’s reduced scope to enact major legislation, given its minority position in Congress, stretches the political uncertainty ahead.

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